Must-know: An overview of the Banking sector

Overview: Development of banking in the US

By Saul Perez
•
Aug 4, 2014 1:44 pm EDT

Development of banking in the U.S.—the early years

Initially, there was no central regulatory authority and all banks issued their own currency or notes. As a result, there was a series of banks with short lives, after which the currency or notes they issued became worthless. In 1791, Alexander Hamilton established a national bank. It was the first bank to set up by a government charter. A charter is an act of the government to set up an institution. However, the bank shut down in 1811 when the charter wasn’t renewed. In 1816 James Madison’s Congress set up a second national bank to cope with the war debt. This bank centralized banking again. However, this bank also shut down when Andrew Jackson didn’t renew the charter in 1833.

The National Banking Act of 1863 and 1864 established a system of national banks to curtail wildcat state banks. However, this didn’t have the desired impact. The following years saw high risk banking practices, while customers were often misled. This caused to a general sense of distrust towards banks. The state of Texas outlawed bankers—a law that stood until 1904. However, a few family houses were set up in this era—a precursor to many of today’s big banks. Family houses like JPMorgan (JPM) and Goldman & Sachs (GS) which were a forerunner of today’s entities. They enhanced their reputation during this era by being consistent in service. As a result, they were able to win customers’ trust.

Formation of the Fed

In response to several small financial panics, the Federal Reserve (or Fed) was established in 1913 to regulate banks. However, stock speculation led to the crash of 1929 which resulted in the Great Depression. Around 10,000 banks failed from 1930–1933. At the peak of the Great Depression in 1933 President Roosevelt asked Representative Henry Steagall and Senator Carter Glass, to reform the Fed. The result was the Glass-Steagall Act, which required banks to either be deposit businesses or investment businesses—debt origination, initial public offerings (or IPOs), and mergers and acquisitions (or M&A)—but not both. As a result, the Federal Deposit Insurance Commission (or FDIC) was also established.

It led to specialized banks like Piper Jaffaray (PJC) which focused on investment banking and banks like U.S. Bancorp (USB) or the majority of banks in an exchange-traded fund (or ETF) like the iShares U.S. Regional Banks ETF (IAT) which focused on deposits. The foundation of modern banking in the U.S. was laid with this act. It defined the evolution of banks over most of the 20th century.

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